When Alice Goodman was writing the libretto for The Death of Klinghoffer, she sensed she was creating something extraordinary. "I was thinking, 'I have never done anything as good as this! By God, I can write! It's great! I'm going to be famous! I'll write another opera! And another! And another!' That's what it felt like."

Her libretto told the story of the real-life murder of Leon Klinghoffer, an elderly Jewish American, by Palestinian terrorists on an Italian cruise liner in 1985. She wrote it mostly at night. "I had a three-year-old daughter who wasn't sleeping much. I did most of my writing between 8pm and 2am, and it was Geoffrey's job to tuck her back in." (Geoffrey is her husband Geoffrey Hill, who in 2010 was elected Oxford professor of poetry.)

When she was done, she was proud of her achievement. "That's what's so hilarious. You always know when you've done something good and – this is what I now find so funny – I assumed everyone else would." But they didn't. When John Adams's opera received its US premiere in New York in 1991, it was charged with being antisemitic and sympathetic to terrorists. Klinghoffer's daughters, Lisa and Ilsa, attended the production at the Brooklyn Academy of Music and issued a statement: "The juxtaposition of the plight of the Palestinian people with the cold-blooded murder of an innocent disabled American Jew is both historically naive and appalling."

Goodman and the rest of the creative team – composer Adams, director Peter Sellars and choreographer Mark Morris – had expected, and perhaps even courted, controversy. (They were, after all, following their 1987 triumph Nixon in China, another opera based on a news event, albeit a much less provocative one.) Adams had been disappointed that the world premiere weeks earlier in Brussels had been so tepidly received. The reaction in New York more than compensated: it proved a devastating shock.

"I couldn't get work after Klinghoffer," says Goodman. "I was uncommissionable. John was almost uncommissionable." Adams's next work was a violin concerto. "No words," says Goodman.

The controversy silenced her creatively for decades, depriving us of the talents of one of opera's most poetic librettist. WH Auden said the most important thing the librettist does is inspire the composer. Goodman did that and more: her two libretti stood on their own as works of art. "I would have liked to have written more than two operas," says Goodman. "But I'm glad those were the ones I wrote."

The controversy served to damn The Death of Klinghoffer to obscurity for nearly two decades. The piece has become a cursed opera, repeatedly refused a home by companies scared of contamination by association. Until it was performed in St Louis last year, it hadn't been staged in the US for 20 years. English National Opera's new production next month will be the first time it has been staged in London – astounding given the popularity of Adams, and the fact that some regard it as his most impressive achievement.

After that New York premiere, two of the five opera companies (the Los Angeles Festival and Glyndebourne) that had commissioned the work withdrew their planned productions. After 9/11, Boston Symphony Orchestra cancelled a performance of extracts.

The Death of Klinghoffer has been attacked from both sides. When it was staged in San Francisco in 1992, the Jewish Information League mounted protests. A decade later, British director Penny Woolcock arrived at the Palestinian film festival, having been invited to screen her film of the opera – only to be told she couldn't show it because the film was thought to be pro-Jewish and anti-Palestinian. Indeed, Sellars, who had had the original idea to make an opera about Klinghoffer's murder, thought Goodman was too hard on the hijackers. "John did, too," recalls Goodman. "I said, 'They're not Smurfs!'"

The opera also seemed hideously prophetic. Adams was recording it for Woolcock's film in September 2001, when he heard about the attacks on the Twin Towers – just after working on Mrs Klinghoffer's last aria. It goes: "If a hundred/ People were murdered/ and their blood/ flowed in the wake/ Of this ship like/ Oil, only then/ would the world intervene." Goodman says, "John heard the news and his hair stood on end."

We're sitting in the front room of the Rectory at Fulbourn near Cambridge. Goodman, born a Jew in Minnesota in 1958, is now a Church of England rector. On the wall is a photograph of her and Hill from 1984. They look very much the iconoclastic intellectuals: the man hailed by critic Harold Bloom as "the strongest British poet now active", and the twentysomething tyro librettist, full of the sexy confidence of youth. "It is, I should say, very old," says Goodman. "The piece of paper I'm holding is a typescript of the first scene of Nixon." At the time, she was living in a grotty flat in Cambridge, while Hill was a resident fellow, meaning he had a nice room in college as long as he didn't get married. "You can't live as a married couple in college. We moved to the States because we couldn't afford to live together as a married couple in Cambridge."

What, 21 years on, does Goodman think of the Klinghoffer controversy? She smiles wryly. "All clergy have to have spiritual directors, the way a psychiatrist goes to see a psychiatrist." I think of Tony Soprano's shrink's weekly visits to her own shrink. "I saw my director yesterday, and I mentioned this had caused a great amount of controversy and had been very tough and that I hadn't done anything else since and he said, 'Why was that?' And I said, 'Well, because the bad people in it are not entirely bad and the good people are not entirely good.'"

This, she argues, was her mistake: to depict terrorists as human beings and their victims as flawed. In one particularly caustic attack in the New York Times in 2001, Richard Taruskin denounced the opera for "romanticising terrorists". Taruskin noted that Adams had said the opera owed its structure to Bach's Passions. But in Bach's Passions, argued Taruskin, every time Jesus is heard, an aureole of violins and violas gives Christ the musical equivalent of a halo. Klinghoffer has no such halo, while the Palestinian choruses are accompanied by the most beautiful music in the opera.

"What upset Taruskin was giving beautiful music to terrorists," snaps Goodman. "They have to sing ugly music. There has to be the equivalent of a drumroll when [1960s cartoon villain] Snidely Whiplash comes in because – God help us – we can't have complexity. People will love evil if we give terrorists beautiful music to sing and we can't have that, can we? Sorry, I can hear my voice becoming high-pitched and irritable.

"There's a certain romanticism to the hijackers and that's something, again, that Taruskin picks upon. But the trouble is they think romanticism is good. Romanticism good, romanticism attractive. I don't think that. I actually think the most dangerous thing in the world is romantic nationalism. Not religion, but romantic nationalism. And if it's true, it's also true for Israel. Israel is not exempt from the problem I have with romantic nationalism. If it's an evil, it's an evil all over the world."

She wrote Klinghoffer at the suggestion of Sellars, and with some trepidation. "It was made more difficult, if you like, because my parents were still alive – very strong people with strong opinions. My family is observant and I had a proper Jewish upbringing and education." She says that, while she stayed away from the more difficult ramifications of that upbringing, she nevertheless plunged right into the "hot quicksand" of the Arab-Israeli conflict, right down into the Biblical roots of Jewish-Muslim conflict in the story of Abraham, Hagar, Isaac and Ishmael (which she meditates upon in the opera's Hagar chorus), and into the vortex of questions about Israel's right to exist and what motivates terrorists.

Writing the libretto was the culmination of a spiritual and ethical journey for Goodman. "The Judaism I was raised in was strongly Zionist. It had two foci almost – the Shoah [the Holocaust] and the State of Israel, and they were related in the same way the crucifixion is related to the resurrection in Christianity. Even when I was a child, I didn't totally buy that. I didn't buy the State of Israel being the recompense for the murder of European Jewry, recompense not being quite the right word, of course. The word one wants would be more like apotheosis or elevation."

She recalls seeing Holocaust documentaries as an eight-year-old. "I remember a film of a little man who'd been put in a vacuum chamber with a window so scientists could observe what would happen to him when the air was withdrawn. The whole film was shown to us as children and the look on his face is something I will never forget. Our very traumatised junior rabbi quoted afterwards the song that begins, 'Cast out your wrath upon the nations that know ye not.' In Hebrew it is, 'Cast out your wrath upon the goyim [a disparaging term for non-Jews],' which is what he said. My infantile brain thought, 'No, that's not the right answer.' That thought is the thing that's brought me here. And it has to do with Klinghoffer as well."

When she says "brought me here", where does she mean? "I mean into holy orders, into the rectory in Fulbourn. It had nothing to do with writing Klinghoffer really, but I was converted about halfway through writing it." Did your conversion shock your family? "It was really difficult. If you're Jewish, Christianity is an apostasy. If my family had been more traditional, they would have said a kaddish [a Jewish prayer often used to mourn the dead] over me. But they didn't."

We walk to the churchyard. In the driveway, she explains the two bumper stickers on her car. WTFWJD stands for "What the fuck would Jesus do?" The other, in Hebrew, translates as "the transformation of the world". Whatever else Goodman is – midwestern Jew turned Cambridgeshire clergywoman, apostate librettist, woman whose brilliant writing career was nipped in the bud – she's not exactly Dawn French's Vicar of Dibley.

Her church is dedicated to Saint Vigor, who tamed then killed a dragon. "It was burning down the local forest, so he was asked as a sort of pest control. He crossed it, put his stole around its neck and led it to the sea where he drowned it. The whole story strikes me as really fishy."

We start talking about Auschwitz. "The guards at Auschwitz were able to do what they did because they had dehumanised the people who came through. It's that whole process of dehumanising that I hate. To have made Klinghoffer into the Klinghoffer the critics wanted would have been to play into that enterprise of dehumanising – dehumanising your enemy, dehumanising your friends as well."

And yet you can understand why Klinghoffer's daughters hated the depiction of their father. Goodman tells me they could have been involved in the project but she resisted. "They had already been consultants for two docudramas." One starred Karl Malden, the other Burt Lancaster. "So it seemed to me they didn't really need a third. Also, having been advisers to these docudramas, they couldn't really say this is all a private family matter because it had become part of the public discourse."

But her libretto gave voice to his murderers' motives. "Yes. It was suggested that I was making excuses for murder." Which she wasn't? "No, I don't think there's any excuse. All the hostages had been moved on to the top of a covered swimming pool. Mr Klinghoffer's wheelchair would not go up there. He was shot below decks and his body thrown into the sea. I think in many ways he was killed as a wheelchair user more than anything else."

She remembers the other libretti she planned to write after Klinghoffer. She envisaged Nixon and Klinghoffer being followed by a third opera to make up a trilogy, tentatively entitled Waco and dealing with the 1993 gun battle between the Branch Davidian sect and US agents in which 76 people died. "It would have had a children's chorus in it and would, of course, have had Janet Reno as a principal character." Reno, who gave the order to attack, was Bill Clinton's attorney general at the time.

Goodman would also have liked to tackle the Elian Gonzalez affair. She would have explored the story of a Cuban boy rescued from shark-infested waters in late 1999 after his mother drowned in a bid to escape Cuba for the US; his months in Florida as attempts by his father to get him back were violently resisted; and the claim that he started working miracles during his American sojourn.

Both stories, of course, are political hot potatoes, laden with religious themes. And both, quite possibly, would make great libretti and operas. But thanks to Klinghoffer, we will probably never know. "Klinghoffer stopped me writing," says Goodman. "But I'm a different person from then. What's always interested me is words as they're heard. Opera for me is the best way of doing performance poetry. That's what a libretto is. But when I preach, that's what I'm doing. So everything I do from the pulpit comes out of what I did as a librettist."

Her passion for words now goes into her preaching. She says her husband sometimes sits in a pew with his head in his hands. Is that not offputting? "It is. But afterwards he'll say, 'That was a very good sermon.'"

• ENO's The Death of Klinghoffer is at the Coliseum, London WC2 (0871 911 0200, eno.org), 25 February to 9 March (in rep).